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Will TransCentury jump or be pushed in RVR share deal?

Monday February 17 2014
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Passengers arrive at the Kisumu railway station in western Kenya aboard a Rift Valley Railways train. FILE

As a March 31 deadline draws closer, East Africa eagerly awaits the end-game of a high stakes gamble by listed Kenyan investment firm TransCentury as it seeks to change the shareholding of Kenya-Uganda rail concessionaire Rift Valley Railways.

TransCentury, often acknowledged as Kenya’s most successful chama (it started as an investment club) has initiated a move that could see it wrest control of RVR from Egyptian investment house Citadel Capital in a transaction in which either firm could end up controlling 84 per cent of the rail operator, depending on who blinks first.

RVR is the current operator of the railway transport system in both Kenya and Uganda under a joint concession granted by the two governments in 2005.

RVR is currently owned by Citadel (51 per cent), with TransCentury holding a 34 per cent stake. Uganda’s Bomi Holdings accounts for the residual 15 per cent.

Although there are three shareholders in the concession, the current tussle involves only the two, after TransCentury chose a put option as its preferred path to possible majority control or exit.

This is a double-edged sword that could turn against the first mover, since it leaves the other party the option to buy out the initiator at the very price he initially proposed.

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READ: Citadel Capital’s plan for East Africa’s growing businesses

In this case, even if the price of the stock declines below the specified price of the put option, TransCentury has the right, but not the obligation, to sell the asset at that very price, while Citadel has the obligation to buy the asset at the strike price.

In this way, TransCentury will receive at least the strike price specified even if the asset is worth less. Put options are used either as a form of insurance against price falls or for speculation.

In a January 30 cautionary notice to the Nairobi Securities Exchange, TransCentury announced that its subsidiary Safari Rail Company Ltd had exercised an option that would result in a change of its shareholding in Kenya-Uganda Railways Holdings Ltd, the lead investor in RVR.

The notice gave Citadel 60 days within which to accept TransCentury’s bid or turn the tables by buying out the former. That period expires on March 31 and the markets are on the lookout for the final play.

The EastAfrican has learnt that part of the motivation could be connected to a recent surge in the number of foreign firms seeking entry into the concession.

“Many big companies, global and regional, have been inquiring about joining the business but that would require one to control more than 51 per cent of the company. TransCentury’s calculation could have been that with the current instability in Egypt and a recent recasting of its strategy, Citadel would not be in a position to match its offer,” explained a source familiar with the goings on.

The question now is whether TransCentury’s assessment of Citadel’s vulnerability was spot on or a major miscalculation, as one regional investor describes it.

Given that the 20 years of the concession still to go, combined with the turnaround in the fortunes of RVR, which broke even last year, and the promise offered by East Africa’s oil and gas economy, foreign players are looking at the rail operator as a good bet, even with a standard gauge railway (SGR) looming on the horizon.

According to sources, however, the prospective entrants, that include Canadian, US and South African companies, and three Kenyan families with deep pockets, will only buy from the shareholder that is able to swallow up the other.

TransCentury alluded to this in its cautionary statement, where it described the transaction as being “in line with the group’s overall strategy to maximise the value of its investments for its shareholders.”

But the Kenyan portfolio manager is understood not to be averse to quitting RVR either. According to an analyst who requested anonymity, the firm invested in RVR without “due consideration to the complexities” of concessions, especially the need for re-capitalisation.

“TransCentury is currently not in charge of the concession. My own notion is that they underestimated the cash needed for this kind of operation. For them to benefit, they have to be on top, or seek value in other plays,” said the analyst.

Although RVR faced a ferocious campaign against its operations last year, a changed terrain has played in its favour, radically changing the company’s prospects.

Not least among these developments is the Kenya government’s push for what some consider an overpriced standard gauge railway, whose economics could make the metric gauge line operated by RVR a cheaper route to the hinterland for the foreseeable future.

According to numbers from a Kenya government study that compares the probable cargo tariffs on the SGR and the RVR metre gauge, the latter will enjoy a cost advantage of almost 50 per cent.

It would cost $723 to ship a container between Mombasa and Nairobi on the SGR, for instance, compared with only $377 on the metre gauge.

Sources in the oil industry also allude to near-term concerns about the threat of terrorism to the operations of the proposed crude export pipeline.

“It is likely that a lot of crude will go to rail while the potential growth that is going to be generated by the oil and gas industry will require a lot of capacity for movement between Mombasa and the hinterland,” said another commentator.

More significant, however, is RVR’s transition from red to black territory. Performance improved from negative to positive EBITDA (earnings before income tax, depreciation and armotisation) in 2013 as investments undertaken over the past couple of years began to pay off.

Some $160 million of a planned $287 million investment package has been injected into the business. That figure is a combination of debt and $80 million in shareholder funds.

RVR is also on a better footing than the SGR, which, according to sources, has not secured funding yet. While the Chinese government has in principle agreed to finance the project, a firm agreement is yet to be hammered out, as concerns mount over the cost of the project.

It is understood that China feels that the $3.6 billion cost assigned to the Mombasa-Nairobi leg makes the project economically unviable.

Studies also show that the SGR will only be nine hours faster than the metric gauge between the two points, a cost shippers will be happy to live with at the lower tariffs the metre gauge will offer.

RVR, which saw a 40 per cent growth in volume of cargo carried during 2013 and a halving in line blockage, has been slowly improving operational efficiency.

The business has been further boosted by new interest by Uganda’s steel industry that has seen one shipper sign a contract to move 10,000 tonnes between Mombasa and Kampala monthly. Running time between Nairobi and Mombasa has improved by six hours while four hours have been shaved off the Malaba-Kampala leg.

All these developments make Citadel’s stake an unlikely candidate for acquisition and in effect, TransCentury may have only succeeded in setting the terms for its exit from the business.

For Citadel, loss of the majority stake in RVR would be a major setback for its plans to emerge as a leading investment company on the continent.

As part of this strategy, Citadel is pursuing control of 10 platforms, including transportation, “with a view to maximising shareholder value through long-term holding periods to take full advantage of prevailing macro trends,” the company said in its financials for 2012.

For TransCentury, a buyout of its stake would end its dalliance with the biggest transportation venture on its portfolio.

Additional reporting by Washington Akumu.

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